Cartoon of the Day: Inflation Shipwreck

Takeaway:Builder confidence slumped again in May. Taking a step back, this is consistent with the majority of recent housing data.

Welcome to The Hedgeye Housing Research Vertical

Today we are introducing our inaugural Hedgeye Housing Vertical research product. The effort is being led by Josh Steiner and Christian Drake from the Financials and Macro teams. Subscribers to Financials and/or Macro verticals are currently set up to receive this product. If you'd prefer not to receive our housing-focused research going forward please let us know.

Our goal is to help investors understand the trends and spot inflection points in the US housing market by tracking 15-20 different housing data series and presenting them in a hyper-simple format. Whenever data hits we will publish a brief note summarizing its importance, or lack thereof. Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.

We've broken the market into four main categories: Home Prices, the existing home market, the new home market, and other miscellaneous data. The focus is on simple supply and demand measurements and whether they're weakening or strengthening, on the margin. We're using red and green to make it easy for investors to gauge, at a glance, whether there's widespread improvement, deterioration or a mixed bag.

As the housing research effort evolves we hope you'll engage us with questions and feedback.

THE BULLS TURN BEARISH: Summarizing the Evolution of our Call

After being discretely bullish on housing for the better part of a year beginning in 4Q12, we turned increasingly negative at the beginning of the year and elevated #HousingSlowdown to a top Macro theme for 2Q14.

The 2Q14 Macro Investment Themes presentation detailing our expectation for an intermediate term slowdown in housing can be found HERE

Additionally, we’ve compiled ~300 housing related research notes that had previously been published within the Financials vertical. That research is now available for review in the new Hedgeye Housing vertical on our website.

Today's Focus: NAHB HMI (Builder Confidence Survey)

This month, the NAHB’s HMI, which measures builder confidence, fell to 45, a drop of one point from April’s print of 46 (which was downwardly revised from 47).

This is the fourth consecutive month of decline/stagnation. While NAHB Chairman Kevin Kelly interprets this as “in line with the market reality of a continuing but modest recovery,” we see it as a clear inflection from the path housing had been on between June 2013 and January 2014, when the HMI posted its strongest post-housing crisis prints (ranging from 51-58).

In February of this year, the index dropped 10 points to 46 with the weakness extending through the latest reading. It's notable that the step function move lower in builder confidence has been geographically pervasive and has persisted in the face of the positive turn in the weather. Though these prints are still well above those of 2008-2011, they do not suggest a housing market in the midst of an accelerated comeback.

At the sub-index level, the components that make up the HMI were mixed. That gauging current sales conditions fell from 50 in April to 48 in May. The component measuring buyer traffic increased two points to 33, and the component gauging sales expectations during the next six months rose from 56 to 57. Once again, these numbers do not speak to great strength; the NAHB expects only a one point increase in sales until the end of 2014.

On a regional level, builder confidence remains strongest in the South and weakest in the Northeast. The only significant movement in regional HMIs was a four-point drop in the West, where the significant and expedited drawdown from the January peak of 71 to 44 in May further extended itself.

While the last four months’ prints have been stronger than those of 2008-2011, they remain weak in comparison to 2013's rising prints. Don’t let ABC News Nightline talk of bidding wars fool you; the recovery is losing momentum and the appropriate question from here is how low will it go?

About the NAHB HMI:

The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The monthly survey has been conducted for 30 years. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next 6 months as well as the traffic of prospective buyers of new homes. The HMI is a weighted average of separate diffusion indices for these three key single-family series. The HMI can range from 0 to 100, where a value over 50 implies conditions are, on average, improving, a value below 50 implies conditions are worsening, and an index value of 50 indicates that the housing market is neither improving nor worsening.

Joshua Steiner, CFA

Christian B. Drake

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05/15/14 12:09 PM EDT

KSS – 1Q Gives Us Greater Confidence in our Short

Takeaway:Not much in 1Q to challenge our Short call. We're taking down our estimates, which are already well below consensus. We'd press it.

Conclusion

No change to our KSS Short Thesis. If anything, the lack of conviction and strategic thought process from management on the conference call reaffirmed our view that the problems at this company go far beyond a singular quarterly report. The weak comp (-3.4%) was not a major surprise given what we’ve seen out of other retailers, but even we didn’t think we’d see anything worse than -2.5%. What’s surprising is that the company held its full year EPS guidance constant despite the $0.03 miss.

We get the favorable impact of a lower tax rate and lower share count. But KSS is taking down D&A – which helps by $0.15 (or 3.7% EPS growth). Companies don’t make a decision to change depreciation rates so early in the year if they’re confident about where they’re headed. Also, KSS didn’t disclose its dot.com growth for the first time in at least three years. KSS has had the best growth rate in e-commerce out of any major retailer over the past eight years (38.9% CAGR) and it has served as a pillar of support for KSS’ growth algorithm. That’s clearly weakening.

And of course, JC Penney as an emerging competitive threat was not mentioned even once on the call. We think the Macro and industry cross currents are going to smack KSS from every direction, and we don’t think it sees it coming. We’re lowering our already below-consensus estimate for this FY by a nickel to $3.84. We don’t see how sales or margins are up for the year. In the outer years, we remain 20-30% below the consensus.

Here’s a few points relevant to KSS from our revenue overlap study from earlier this week regarding JCP and KSS. The punchline – based on a detailed analysis – is that JCP has about 300 stores to close. We overlapped each of those locations with every KSS store market by market to gauge the potential revenue windfall for KSS, as we viewed a meaningful revenue shift from JCP closures as one of the few risks to a KSS short. In the end, it was far less than we suspected.

1. Revenue Impact of Closures. Our math suggests that these stores would only result in about $550mm-$600mm in revenue loss to JCP. Importantly, KSS only overlaps in 42% of these markets. Our research shows that KSS took about 19% of the $5.4bn in sales JCP hemorrhaged over the past three years. If we apply a 20% share gain level to this analysis for KSS, it suggests about $73mm, or less than 0.4% to KSS in comp. If you want to get more aggressive and assume that KSS takes 100% of that revenue (which WMT won’t allow) you’re looking at about 1.9% in comp to KSS. We think something far below 1% is closer to reality. Here’s the sensitivity analysis below.

2. No Growth KSS. This analysis suggests to us that KSS can only add stores in lower demographic areas. We fully recognize that there are few people running around touting KSS as a unit growth story. But this math is definitely worth sharing. The numbers on the horizontal axis refer to JCP’s entire store base. The bucket to the far left is represents the most attractive demographic locations. The bucket to the far right represents the least attractive locations. The columns show the percent overlap KSS has in each bucket of those JCP stores. The point is that in the top 600 locations, KSS has near 100% overlap with JCP. Then it begins to tail down slightly – with the only real opportunity for growth in JCP’s worst 300-400 markets.

3. KSS Has The Greatest Exposure to JCP Prior (Not Future) Share Loss. Every time we conduct a survey, we look at the dispersion of the of the lost JCP business by retailer. We had a lot of people argue with us over the past two quarters when we presented our 18-19% share stat – but this time around, it was validated yet again. The numbers suggest that KSS captured about $1bn of the $5.4bn JCP gave away. WMT is slightly higher, but as it relates to percent of each retailer’s sales, no one even comes close to KSS at 5.3% of total sales.

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05/15/14 11:50 AM EDT

BOBE: Asset-Light Is Right

Ron Ruggless of Nation’s Restaurant News published a relevant and timely article yesterday afternoon, highlighting the wave of private equity activity that hit the restaurant industry last year. David L. Epstein, principal with the Chapman Group, was particularly complimentary of the refranchising efforts of Applebee’s (DIN) and Wendy’s (WEN) in 2013. Similar to us, Epstein is surprised by the lack of transactions in 2014:

“I thought the huge success Wendy’s and Applebee’s have had in selling their corporate units to franchisees that a lot of other restaurants would see that and embark upon the same thing, but we haven’t seen that.”

As you know, we’ve been strong advocates of a potential refranchising effort at Bob Evans Farms (BOBE), suggesting that the transition to an asset-light model would benefit the company greatly. We typically point to the successful restructuring Jack in the Box (JACK) has undergone over the past few years, but Applebee’s is another reminder of the significant value that can be created under such a scenario.

We continue to believe BOBE would benefit from a reliable, diversified revenue stream and lower-risk business. Suggestions that refranchising is merely a financial engineering event are heavily misleading. In fact, franchisees have been known to run better restaurants than the franchisors running the brand, which would hypothetically lead to improved sales, traffic and brand perception. BOBE would benefit greatly from finding a few franchisee partners to address the operational issues plaguing the company and recent history suggests there is significant appetite for these types of deals.

We surmise the appetite on Wall Street would be as strong – investors tend to favor asset-light operators, often awarding these companies with premium multiples. In our view, it’s a win-win.

Howard Penney

Managing Director

Fred Masotta

Analyst

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05/15/14 10:41 AM EDT

Sell Growth: SP500 Levels, Refreshed

Takeaway:The weather turned, but the consumption data that matters most didn’t.

Editor's Note:This research note was originally sent to subscribers on May 13, 2014 at 10:04 a.m. EST by Hedgeye CEO Keith McCullough. Follow Keith on Twitter @KeithMcCullough.

Hedgeye Retail: Wal-Mart Plays Right Into #GrowthSlowing | $WMT

Takeaway:Not a great start for new CEO Doug McMillon.

The chart below shows what everybody already knows: Walmart comps disappointed. The company cited weather for 20 basis points of the decline. And if there's any retailer who's data we trust, it's Wal-Mart's.

But the two-year trend, which we place much heavier weight on as it relates to drilling down the real underlying trend, is nothing to write home about. This plays right into Hedgeye's #GrowthSlowing theme as it relates to the US Consumer.

The more telling visual is the earnings per share (EPS) miss. In 11 years, Wal-Mart has only missed 12 times, and nine of those were by a penny. Today it missed by a nickel. That's only happened once before – in 2007.

The blue bars in this chart show the absolute EPS variance to consensus for each quarter. The dots refer to the right axis showing the percent beat or miss in each period. Not a good way to start things off in the first quarter for new CEO Doug McMillon.

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Editor's Note: This research note was originally sent to subscribers on May 15, 2014 at 8:36 a.m. EST by Hedgeye Retail sector head Brian McGough. Follow Brian on Twitter @HedgeyeRetail.

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